Report details AT&T wait to break even on iPhones

With its large subsidies to Apple, AT&T doesn't break even on iPhone accounts with high data-usage until the 17th month of a 24-month contract, according to a new report from Yankee Group.

The report, titled "The Golden Subsidy Egg's Goose is Cooked: Welcome to the Brave New Subsidy-Free World," looks at the downside of subsidies paid to manufacturers by cell phone carriers. The report cites AT&T's iPhone contract with Apple as a prime example.

Subsidies have typically helped mobile carriers offer customers free or low-cost devices in order to lure them into buying long-term service contracts. Smartphone owners are happy because they're getting the latest devices at rock-bottom prices. But the surge in data use and the rising cost of grabbing new customers are cutting profit margins for providers, says Yankee Group.

With the mid-2008 launch of the iPhone 3G, AT&T struck a subsidy deal with Apple that slashed the price to consumers to $199 for the low-end version but forced the carrier to bear the upfont costs of each unit. Several published reports have estimated that AT&T's subsidy is at least $300 per phone. (Neither AT&T nor Apple responded to requests for confirmation.)

At the time, AT&T acknowledged that the new deal would impact profit margins and dilute earnings. The company's second-quarter results did show a dip in both revenue and earnings.

AT&T went along with the subsidy because it felt that lower iPhone prices would bring in more customers. But in a catch-22, more customers have also put a strain on the carrier's network, both for voice and data. Ralph de la Vega, CEO of AT&T Mobility and Consumer Markets, said in August that AT&T's wireless data usage jumped almost 5,000 percent from 2006 to 2009.

That strain has made for some unhappy iPhone users and has forced AT&T to scramble in order to beef up its wireless infrastructure.

Removing the subsidy for AT&T would win the company a total return of 33 percent over a two-year contract and reduce the break-even point to eight months, Yankee Group said.

Moreover, unless mobile carriers in general can cut their reliance on subsidies, Yankee Group noted, they may see profit margins fall even further.

"Until now, North American operators have been kings of the devices market, controlling distribution and bearing many of the risks," Andy Castonguay, Yankee Group director and author of the report, said Thursday in a statement. "Rising customer acquisition costs, exclusivity fees and flat-rate pricing are squeezing margins for coveted smartphone users. To reverse this trend, operators must spread the control and risks across OEMs and retailers to offer more affordable options and establish greater levels of clarity and trust with consumers."

Below is a graphic from Yankee Group's report: